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Buy Europe to Access Emerging Market Growth

A easing in trade tensions between the US and China is positive for European stocks, which derive a third of their sales from emerging economies

David Brenchley 12 April, 2019 | 3:30PM

Ferrari, European equities, stock market, emerging market, China GDP growth

Fears over global trade dragged markets down in 2018, but stocks have rallied in the first three monts of 2019 on hopes for an easing of trade tensions between the US and China.

The trade war dragged emerging market stocks, particularly Chinese ones, down lower than most last year, with the MSCI EM Index declining 14.5% in US dollar terms. But it also hit European stocks. The slowdown in global trade combined with country-specific issues to send MSCI Europe down almost 15%. In contrast, the broader MSCI World Index fell by just 8.7%.

Commentators now expect an imminent resolution of the trade war that built up between the US administration, led by President Donald Trump, and its Chinese counterparts. As a result, stock markets have powered ahead year to date. While they haven’t quite made up last year’s losses, MSCI EM is up 13% and MSCI Europe 13.8%.

The reason Europe was hit hard alongside emerging economies is because the Continent has a large exposure to global trade and particularly emerging markets. While the spectre of Brexit is a slight worry for European firms, it pales into insignificance when compared with fears over a downturn in trade.

“Europe is very geared to the global economy, and to emerging markets,” explains Vincent Ropers, fund manager at Wise Funds. He explains that around a third of European companies’ sales come from emerging nations, compared with around 5% in the UK.

China's Impact on European Equities

Lucy MacDonald, chief investment officer for global equities at Allianz Global Investors, agrees, noting that the two biggest real downside risks to Europe over the past year have been from China and the structural issues in the automotive industry.

Zehrid Osmani, manager of the Legg Mason Martin Currie European Unconstrained fund, adds: “When the market was selling off at the back end of last year it was on a combined fear of a hard landing in China and the whole issue about China-US trade wars.

“This was clearly putting a strong negative pressure on the economic momentum not just in China but globally.” Osmani says he used that period as an opportunity to buy names that had become 30% or more cheaper than they had been 12 months previously.

So, the thawing in tensions between the US and China has been welcomed by both European fund managers and global or multi-asset fund managers positive on European equities.

MacDonald, who runs the Morningstar Bronze-rated Brunner Investment Trust (BUT), is one of the latter. “We have got an overweight to Europe, but it’s an overweight to European-based companies, not to domestic Europe,” she explains.

MacDonald is expecting a stabilisation in China, which is seeing its GDP growth slow from 7% a year to 6.5%. Indeed, we’ve already seen some positive surprises in March data, as China’s purchasing managers’ index climbed back into expansionary territory.

“Chinese authorities have so much firepower in terms of fiscal, monetary and infrastructure spending that it is going to continue to have an impact on the economy,” adds MacDonald.

And even if China’s economy is slowing, adds Ropers, at 6.5% it’s still growing at a quicker clip than developed economies. Ropers has already outlined his positive views on China and emerging markets, having added Fidelity Special Situations (FCSS) to his TB Wise Multi-Asset Growth fund.

He’s recently also added TR European Growth (TRG), at around a 12% discount, to take advantage of Europe’s emerging market exposure. Colleague Philip Matthews also says he’s added European Assets (EAT) to the TB Wise Multi-Asset Income fund, at around an 8% discount.

Long-Term Trends to Exploit

For equity managers, there are plenty of ways to play long-term emerging market trends. The rate of GDP growth in emerging countries is likely to outpace developed economies twofold, explains Osmani.

His portfolio is very much tailored towards taking advantage of a demographic change and increased urbanisation in emerging markets. In countries like China, India and others there will be a rise in the middle-class population. These aspirational consumers will have better taste and more buying power than previous generations and are keen to own big name, Western brands.

The largest proportion of the investable universe of these companies is focused on consumer brands. Indeed, of the 105 companies in the MSCI Europe with EM Exposure Index, around a third are in the consumer staples or consumer discretionary sectors.

MacDonald and Osmani both own German sportwear manufacturer adidas (ADS), which has strong exposure to China, and luxury goods seller Richemont (CFR). Fellow luxury goods producers like Moncler (MONC), Gucci owner Kering (KER) and car maker Ferrari (RACE) are other plays, says Osmani.

MacDonald also points to Schneider Electric (SU), which is tapping onto energy efficiency in China, an area that is accelerating.

ASML (ASML), which is held by Osmani, is one of the biggest weightings in the MSCI Europe with EM Exposure Index, along with a few other industrial names. Healthcare companies and life insurers are exposed to emerging markets, too.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
adidas AG278.40 EUR0.00
ASML Holding NV254.15 EUR0.00
Brunner Ord862.00 GBP-0.23
Cie Financiere Richemont SA74.54 CHF0.00
European Assets Ord106.52 GBP1.45
Ferrari NV149.00 EUR0.00
Fidelity China Special Ord215.00 GBP0.23
Kering SA544.90 EUR0.00
Legg Mason IF MC Eurp Uncons A Inc £4.10 GBP0.74
Moncler SpA41.30 EUR0.00
Schneider Electric SE90.46 EUR0.00
TB Wise Multi-Asset Growth B Acc342.00 GBP-0.50
TB Wise Multi-Asset Income B Inc118.99 GBP-0.30
TR European Growth Ord914.50 GBP0.00

About Author

David Brenchley

David Brenchley  is a Reporter for Morningstar.co.uk

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